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Sustainable growth

Economic
growth occurs when real output increases over time. Real
output is measured by Gross Domestic Product (GDP) at
constant prices, so that the
effect of price rises on the value of national output is removed.

Sustainable
economic growth means a rate of growth which can be maintained without
creating other significant economic problems, especially for future
generations. There is clearly a trade-off between rapid economic growth
today, and growth in the future. Rapid growth today may exhaust
resources and create environmental problems for future generations,
including the depletion of oil and fish stocks, and global warming.

Periods of growth are often triggered by increases in
aggregate
demand, such as a rise in consumer spending, but sustained growth must involve an
increase in output. If output does not increase,
any extra demand will
push up the price level.

Growth based on debt

In terms of sustainability, it may be argued that growth based on
short-term public debt, rather than long term productivity, is
unsustainable - hence worries about the build-up of sovereign debt in
Europe.

PPFs and economic growth

For an
economy to continue to grow in the future, it needs to
increase its capacity to grow. An increase in an economy’s productive
potential can be shown by an outward shift in the economy’s PPF.

Standards of living

Gross domestic product per capita is
often regarded as the key indicator of the standards of living of the
citizens of an economy, and of their economic welfare, though broader
measures of economic welfare are increasingly used in preference to
narrow GDP measures.

Measuring growth

GDP is the
official base measure of output used in most economies, including the UK.
Gross measurements record the output of all goods and
services, including capital goods which have been purchased to
replace existing capital goods. Replacing capital is called capital consumption, or
depreciation. The alternative to Gross output is Net
output, which indicates that depreciation is taken into account
and deducted from the gross measurement.

Domestic product is the value of all UK goods and services produced, including
those produced for
export. It does not include property income which flows into
and out of the UK economy. Property income refers to income from
various types of investment abroad, such as profits and dividends.
When this is added, the measure becomes national
product, called Gross
National Product, GNP.

Growth can be measured as an annual percentage increase in real GDP, and in
terms of a general trend. The trend rate of growth is the long term
non-inflationary average rate of growth for an economy. In the UK it is
around 2.5% per year.

Why is stable growth an economic objective?

If growth rises significantly above or below the
trend rate, the economy is experiencing excessive growth or low growth.
If the rate becomes negative for at least 2 quarters in succession, the
economy is in recession.

The trade
(growth) cycle

Changes in real national income tend to be cyclical, but it is
desirable that this cycle is stable rather than unstable.
Unstable growth is popularly called ‘boom’ and ‘bust’.

Although an economy’s growth is cyclical in nature, the
underlying ‘trend’ can be derived from annual growth statistics. Trends
can be calculated by using a technique called moving averages. The UK
trend rate over the last 25 years is around 2.5%.

Low or negative growth can lead to:

Predicting turning points

Changes, or turning points, in the level of national
income can be predicted and confirmed using economic indicators. Leading
indicators typically monitor changes in interest rates, business
confidence and new housing starts-ups - all of which provides clues to
the next turning point in an economy’s growth cycle. Changes in these
indicate that GDP is likely to change in 12 to 18 months time. The
OECD’s main indicator, the Composite Leading Indicator (CLI), tracks
deviations from the long-term trend, which provides an early warning
system for policy makers.

A short leading indicator can be used to monitor
changes in consumer credit and new car registrations. A lagging
indicator monitors changes in unemployment and real investment and
confirms that the turning point has occurred. All indicators help policy
makers decide when to implement a policy and by what degree.

UK
growth rates

UK growth
rates can be expressed in an index or as annual percentages.

GDP

National income chart will load here!

The advantages of growth

Economic growth is associated with a
number of material benefits which increase economic welfare. These
include the following:

Higher GDP per capita

A rise in real national income means that
wages and
profits are likely to rise. Assuming a stable population, this will
raise GDP per capita.

More public and merit goods

A growing economy means that the public sector
can receive more tax revenue and more resources can be allocated to
public and merit goods, such as more roads, hospitals and schools.

Positive externalities

Public and merit goods generate considerable
external benefits. More hospitals and schools mean a healthier and
better-educated population, which generates other economic benefits in
terms of the effectiveness of the labour force, and increases in
long-term aggregate supply.

More employment

Growth is clearly likely to stimulate demand
for labour, and it is likely that more people will be employed and fewer
unemployed.

The disadvantages of growth

Negative externalities

As production and consumption increase,
negative
externalities, such as pollution and congestion, are
likely to arise. There is also the likelihood of increased depletion of
non-renewable resources, such as fossil fuels.

Widening income gap

Growth can also widen the distribution of
income, because some groups may benefit much more than others. Certainly
in the UK, the relative income gap has widened during the growth years
of 1992 to 2008.

Limitations of using GDP per
capita over time

There are several limitations of using
GDP statistics for comparing changes in economic well-being over
time, including:

Changes in the distribution of income

Average GDP per capita may rise over
time, but the distribution of income may widen. For example, a
rise in the mean average income per head can be misleading because the
average may rise because just a few of the population increase their
personal income. Indeed, the mean average can rise, but the median,
the mid-point in a range of numbers, can fall.

Differences in hours worked

People may be working longer hours, in which case
some of the growth may be through increased work, rather than through
increased efficiency.

Unpaid work is not recorded

People may undertake unpaid work, and this may not
be officially recorded.

Price changes

Prices are unlikely to remain constant over
time, so GDP figures must be converted to at constant prices
and measured from a base year. This process is called ‘indexing’ and is
required to avoid the distorting effects of inflation.

Negative externalities

The quality of life may suffer as GDP increases, although
this is not included in GDP statistics. For example, more driving raises GDP, but also adds to CO2
emissions, which can reduce the quality of life.

Changes in the quality of products

Over time the quality of products tends to
increase, so a given amount of income per capita in 2010 may purchase a
higher quality product than it did in 2000. This is certainly true with
high-technology consumer products, like PCs, laptops and mobile phones.

Limitations of using GDP statistics for
international comparisons

Limitations of using GDP statistics for
international comparisons include:

Differences in the distribution of income

Although two countries may have similar GDP
per capita figures, the distribution of income in each country may be
very different.

Differences in hours worked

As when comparing a country over time, the
number of hours worked to generate a given level of income may be quite
different. For example, workers in the UK tend to work longer hours than
those in France, and this would falsely inflate the GDP figures in the
UK relative to France.

International price differences

International prices will also vary. This is
significant because an individual's purchasing power is based on price in relation to
income. To solve this problem, GDP statistics can be re-calculated in
terms of
purchasing power. The purchasing power of a currency refers to the
quantity of the currency needed to purchase a given unit of a good, or
common basket of goods and services. Purchasing power is clearly
determined by the relative cost of living and inflation rates in
different countries. Achieving purchasing power parity means equalising the
purchasing power of two currencies by taking into account cost of
living and inflation differences.

For example, if we simply convert GDP in Japan
to US dollars using market exchange rates, relative purchasing power is
not taken into account, and the validity of the comparison is weakened.
By adjusting rates to take into account local purchasing power
differences, known as PPP adjusted exchange rates, international
comparisons are more valid.

Difficulty of assessing true values

The true value of public goods and merit goods,
such as defence, education and transport
infrastructure is largely unknown. This means that it is difficult to compare
two countries with very different levels of spending on these goods and assets.

The unofficial economy

Similarly, the existence of a large unofficial economy
may make comparisons based on official GDP very misleading. For example,
comparing the official GDP of the UK and Russia may be misleading
because of the size of Russia's unofficial economy. While all countries
have unofficial economies, their size and significance can vary
considerably.

Currency conversion

GDP figures for different countries must be
converted to a common currency, such as the US dollar, and
this may give misleading figures. For some countries, exchange rates against the US dollar
may be unrepresentative of the true value of the currency, especially
where international trade is
relatively small. In such cases, converting to US dollars may
significantly under-value national output. This explains why conversion
to purchasing
power parity is often preferred to conversion to US dollars.

Sustainable development
and quality of life

In recognising that economic welfare is not simply
about economic growth, in 1999 the UK government introduced a policy for
sustainable development, and refined this further in 2005.

Sustainable development is considered in four main
categories using 20 main indicators, and 68 indicators in total. The
categories are: